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The Predictive Value of Expenses Excluded from Pro Forma Earnings

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Abstract

We investigate the informational properties of pro forma earnings. This increasingly popular measure of earnings excludes certain expenses that the company deems non-recurring, non-cash, or otherwise unimportant for understanding the future value of the firm. We find, however, that these expenses are far from unimportant. Higher levels of exclusions lead to predictably lower future cash flows. We also find that investors do not fully appreciate the lower cash flow implications at the time of the earnings announcement. A trading strategy based on the excluded expenses yields a large positive abnormal return in the years following the announcement, and persists after controlling for various risk factors and other anomalies.

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Authors and Affiliations

  1. University of Michigan Business School, USA

    Jeffrey T. Doyle & Mark T. Soliman

  2. University of Michigan Business School, 701 Tappan Street, Ann Arbor, MI, 48109-1234

    Russell J. Lundholm

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  1. Jeffrey T. Doyle
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  2. Russell J. Lundholm
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  3. Mark T. Soliman
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Doyle, J.T., Lundholm, R.J. & Soliman, M.T. The Predictive Value of Expenses Excluded from Pro Forma Earnings. Review of Accounting Studies 8, 145–174 (2003). https://doi.org/10.1023/A:1024472210359

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